CMBS and MBS

(Question)
Which of the following statements regarding the difference between the risk profiles of an MBS and a comparable CMBS is least accurate?

A. Relatively illiquid CMBS properties will increase the degree of balloon risk to the investor.
B. Contraction risk for a CMBS is significantly lower if the issue contains a defeasance provision.
C. Shortfalls in cash flow from the underlying properties of a CMBS can be augumented by the sale of the properties or the borrowers' other assets.

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Answer: C

Commercial mortgage-backed securities (CMBS) are collateralized using non-recourse loans on commercial (i.e., income-producing) properties. Non-recourse means that the only cash flow support provided from the loan comes from the ability of the property to generate income and from the value of the property itself. The lender cannot seize personal assets of the borrower to satisfy any portion of the unpaid obligation.

Balloon risk: The risk that a borrower will not be able to make a balloon (lump sum) payment at maturity due to a lack of funding.

Defeasance (provision): It voids a bond or loan when the borrower sets aside cash or bonds sufficient enough to service the borrower's debt. The borrower sets aside cash to pay off the bonds, therefore the outstanding debt and cash offset each other on the balance sheet and don't need to be recorded.